Seyfarth Synopsis: On June 23, 2020, the Department of Labor (“DOL”) issued a proposed regulation amending the fiduciary regulations governing investment duties under the Employee Retirement Investment Security Act of 1974 (“ERISA”). This proposed regulation provides guidance for an ERISA fiduciary considering an investment or investment strategy based on “non-pecuniary” factors such as environmental, social or corporate governance (“ESG”) or sustainability factors. The DOL indicated that its proposal is in response to increasing interest in ESG and sustainability investing, and no clear standard for what constitutes an ESG investment. Any comments on the proposal are due by July 23, 2020.

Many say that planet Earth, our only home, is at a turning point: climate change, a worldwide pandemic causing significant economic uncertainty, along with geo-political and social unrest exacerbating that economic uncertainty. In response to these and other concerns, some investors have focused on investments that emphasize the environment or other social good. Examples include alternative energy sources (e.g., electric, solar, wind), as well as alternative farming or food production — think Beyond Meat‼ No one should question an individual’s motives when he or she makes such an investment or divests from an investment deemed not environmentally worthy; it’s their money.

But, how does this translate when selecting investments for an ERISA plan — should plan investment fiduciaries look to achieve social good through the investment of a plan’s assets? It is reported that at the end of the first quarter of 2020, total US retirement plan assets stood at $28 trillion, of which approximately $7.7 trillion is held in defined contribution plans and $11 trillion is held in pension plans.[1] That’s a lot of money, and a lot of money that could potentially be invested for social good. But, as the DOL makes quite clear in its recently proposed regulations, a plan fiduciary is not investing his or her own money; rather, that money is to provide benefits to the participants. So here’s the dilemma that investment fiduciaries face today — do social investing concepts have a role when investing ERISA plan assets?

Historically, the DOL has provided guidance concerning ERISA’s fiduciary duties and responsibilities when a plan investment is selected based on non-pecuniary factors like ESG factors. The DOL’s concern about ESG investing under ERISA, which triggered this proposal, is reflected in the preamble. The DOL specifically stated: “[p]roviding a secure retirement for American workers is the paramount, and eminently-worthy, ‘social’ goal of ERISA plans; plan assets may not be enlisted in pursuit of other social or environmental objects.”

The proposed regulation identifies a number of items a fiduciary must consider when reviewing a proposed investment or investment strategy for an ERISA plan to satisfy its duties of loyalty and prudence. The regulations make it clear that fiduciaries should evaluate those investments based solely on pecuniary factors that have a material impact on the risk and return of the investment, and they should not subordinate the plan’s financial interests to unrelated objectives, sacrifice investment return or take addition risks to promote interest unrelated to the financial interest of the plan.

The DOL does acknowledge in the proposal that ESG or other similar factors could be pecuniary factors if qualified investment professionals would treat those factors as material economic considerations under accepted investment theories. If the fiduciary selects an investment with a non-pecuniary factor (e.g., ESG), then the fiduciary must document why that investment was chosen based on all the relevant factors specified in the proposed regulations, and how it is in the interest of the plan and its participants.

The proposed DOL regulation includes special rules for investment options that are offered under participant-directed defined contribution plans. Those regulations do not prohibit offering a prudently selected, well-managed and properly diversified ESG option under such a plan but they provide a standard that would make it difficult (if not impossible) for a participant-directed defined contribution plan to offer one or more ESG investment options in its investment option line-up. The proposal specifically prohibits designating an ESG option as the qualified default investment alternative (“QDIA”) or a component of the QDIA.

In summary, we are left with the question: Is it ill-advised for plan fiduciaries to engage in ESG investing? Many would look to Beyond Meat as an example of an ESG investment. That ESG investment returned over 100% in the 14 months since its IPO in May 2019. Not too shabby. So it’s possible that an ESG fund would be a prudent investment for an ERISA plan. And, as BlackRock’s CEO, Larry Fink, posited in his annual letter to shareholders, sustainability is a required factor when looking for economically prudent investments. But, if the proposed regulation is finalized, the DOL has made it harder for a fiduciary to defend an ESG investment as appropriate under for an ERISA-governed plan.

If you are concerned about an existing non-pecuniary investment or investment strategy (e.g., an ESG or sustainability investment) or are interested in such an investment or strategy, be sure to contact your Seyfarth Shaw employee benefits attorney. If you would like to comment on the proposed regulation, remember that they must be submitted to the DOL by July 23, 2020.

[1] The remainder, another $9.2 trillion, is invested in IRAs.